Getting the best strategic bond fund for your client

Mr Lamb says advisers should look very carefully at how the fund is run to ensure it meets the specific requirements of each client.

On top of the usual questions that an adviser should ask any fund manager - past performance, research capabilities, tenure of manager and so on - Mr Lamb says it is important to fully understand the investment remit of the fund, especially across five key areas:

1. Use of derivatives. Does the fund use derivatives and, if so, does it do so with the aim of mitigating risk or primarily to add ‘alpha’ return?

2. Equities investing. Under the flexible sector category some funds will hold equities, which will obviously change the risk profile and could have wider implications for portfolio risk.

3. Specific mandates. Does the fund focus on a specific area, such as high yield or emerging market debt? Does the fund have a geographical focus or is it more broadly based?

4. Duration management. How does the fund manager seek to manage duration to mitigate interest rate risk, which is particular pertinent in the current market?

5. Performance basis. Is the aim absolute (positive in all market conditions) or relative (better than peers) performance?

Gill Hutchison, head of investment research at City Financial, says the diversity of the sector is helpful in providing a wide choice but brings challenges in understanding individual fund mandates.

Ms Hutchison says: “It is important not to be distracted by a fund’s positioning in the performance table given the heterogeneity of the sector. Each fund should be assessed on the basis on what it is aiming to achieve.”

To get to grips with the fund’s objectives, Ms Hutchison says advisers should ask managers the following:

• What are the fund’s parameters? Are there any structural biases?

• What should investors expect in risk and return terms?

• Is there a higher income objective or is the manager more focused on the overall total return?

• Does the firm have competence and experience in all areas covered by the fund’s mandate?

• How actively are derivatives used? Are they used primarily for hedging positions or are they also used to express directional views (positive and negative)?

• How has the fund’s positioning evolved through time? How rapidly does positioning alter?

• To what extent have any structural biases found favour in, or been challenged by, prevailing market conditions?

• Is the flexibility of the mandate compromised by the size of assets under management in the fund/strategy?

Elaborating on the wider remits deployed, Mark Wright, fund manager of the CF Seneca Diversified Growth fund, says investors are faced with a choice between managers who prioritise income generation, and others will focus on delivering a total return through capital appreciation and income.

In the pursuit of absolute-like returns, Mr Wright says managers may use derivatives in various ways, for example, to reduce a portfolio’s sensitivity to rising interest rates or to an increase in credit spreads (extra return investors demand over and above coupon yields for bearing credit risk).

Stuart Rumble, investment director for fixed income at Fidelity Worldwide Investment, says your client’s appetite for risk should dictate the type of strategic bond fund they invest in.

For more risk-averse client, Mr Rumble says funds with a greater degree of control built into their strategic asset allocation – such as a mandated greater exposure to government bonds and investment grade corporates – are more advisable.

Additionally, Mr Rumble says some strategic bond funds are more focused on delivering income than others and this might be suitable for the more conservative client considering this option.

He says: “The client’s need for income is something you should bear in mind when recommending funds.

“Finally and most importantly, you should consider how the strategic bond fund fits into your client’s overall investment portfolio. An overall portfolio should be well diversified and the various investments should behave differently under different market conditions.

“For this reason, it is important to look at strategic bond funds that will perform differently to equity markets. As a rule, a fund’s high yield exposure is a good barometer... funds with a greater exposure to high yield bonds are likely to perform similarly to equity markets.

“The fund’s historic track record should also demonstrate whether the fund manager has been delivering on his risk and return objectives.”

Given the flexibility of these types of funds, Azim Meghji, head of UK fixed income at Santander Asset Management, and fund manager of the Santander Strategic Bond fund, says getting to grips with risk control and effective risk management is critical to understanding potential rewards or losses.

Mr Meghji says: “If a manager can’t give a coherent answer about the risk management framework they operate within then walk away.”